Openness to trade as a determinant of the macroeconomic elasticity of substitution

Several theoretical and empirical studies on economic growth consider the macroeconomic elasticity of substitution between capital and labor as a measure of economic flexibility that depends on technological as well as institutional aspects. One institutional aspect of economic flexibility is openness to trade. I examine in a Heckscher–Ohlin model with two large countries trading intermediate goods how openness affects the elasticity of substitution. If the technology has a constant elasticity of substitution in a closed economy, opening up to trade raises the elasticity of substitution only in the country that accumulates capital at a faster rate.     

Comment on “The endogenous aggregate elasticity of substitution for a small open economy”

This note applies the approach of Miyagiwa and Papageorgiou [Miyagiwa, K. and Papageorgiou, C., 2007. Endogenous aggregate elasticity of substitution. Journal of Economic Dynamics and Control 31, 2899–2919] to provide simple frameworks for endogenizing the aggregate elasticity of substitution between capital and labor for a growing small open economy.     

Structural Change in the External Balances Response to Macroeconomic Policies: Perspective from a Two‐Sector New Open Economy Macroeconomic Model

The response of the Japanese trade balance against expansionary macroeconomic policy shocks changed from positive to negative in the 1990s. With consideration of intratemporal (between tradable and nontradable goods) and intertemporal elasticity of substitutions, we investigate this cause using two‐sector new open economy macroeconomics (NOEM). Empirical methods, considering structural change, were applied and show that before the break, intratemporal elasticity of substitution dominates, but subsequently the relation inverted and intertemporal elasticity became predominant and hence, the theoretical response of trade balance changed. Finally, we verify this theoretical implication empirically by impulse response analysis of structural vector auto regression.     

Japanese Foreign Investment and the “Land Bubble”*

The aim of this paper is to examine the determinants of Japanese net long-term capital flows in the 1980s and early 1990s. A basic framework is proposed which takes account of Japan's so-called land bubble by incorporating the interaction of land with the banking sector in a macroeconomic portfolio model of capital flows. Empirical evidence is supportive of the hypothesis that land-related bank loans have been a major determinant of Japanese net long-term foreign investment. the hypothesis of substitution between direct and indirect foreign investment also receives support, and areas of future research are mentioned.     

The macroeconomic effects of fiscal policy in a stochastically growing economy

This paper develops a stochastic model of endogenous growth with productive government expenditure. Herein, we specify the CES production function according to recent empirical evidence. The elasticity of substitution plays a key role in determining macroeconomic performance and the effectiveness of fiscal policy under uncertainty. Results demonstrate that a large elasticity of substitution provides a large expected growth rate and also large volatility of the growth rate. Regarding these effects, the growth-maximizing tax rate and welfare-maximizing tax rate under uncertainty are larger or smaller than those of deterministic economy according to the elasticity of substitution.     

The case for a “productivity norm”: Comment on Dowd

Instead of aiming for zero inflation, a “productivity norm” would allow permanent changes in the price level reflecting opposite changes in productivity or unit costs of production. Dowd (1995) disputes my claim that a productivity norm would be more conducive to macroeconomic stability than a stable price level. But Dowd's arguments succeed in undermining the case for a productivity norm only to the extent that they also undermine his own case for zero inflation.     

Uniqueness and comparative statics of Nash equilibrium in a tariff retaliation model

This paper considers uniqueness and comparative statics of Nash equilibrium of a tariff retaliation model. The approach to the problem is geometrical and reminiscent of the analysis for the free trade competitive equilibrium. If the countries have constant elasticity of substitution utility functions, some simple conditions can be used to prove uniqueness of the Nash equilibrium of the tariff retaliation game. The welfare effects of endowment changes are analyzed in terms of the standard terms of trade and volume of trade effects. If the elasticity of substitution of one of the countries is sufficiently high, immiserizing growth will not occur.      

Capital–skill complementarity and inequality: A sensitivity analysis

Krusell et al. in [Krusell, P., Ohanian, L., Ríos-Rull, J.V., Violante, G.L., 2000. Capital–skill complementarity and inequality: A macroeconomic analysis. Econometrica 68 (5), 1029–1053] analyzed the capital–skill complementarity hypothesis as an explanation for the behavior of the US skill premium. We refit Krusell et al.'s [Krusell, P., Ohanian, L., Ríos-Rull, J.V., Violante, G.L., 2000. Capital–skill complementarity and inequality: A macroeconomic analysis. Econometrica 68 (5), 1029–1053] model with two alternative capital equipment price series: One proposed by Greenwood et al. [Greenwood, J., Hercowitz, Z., Krusell, P., 1997. Long-run implications of investment-specific technological change. Amer. Econ. Rev. 87 (3), 342–362] and the official, revised National Income and Product Accounts (NIPA) data. We find that capital–skill complementarity is preserved, but other results were sensitive to the data used. Specifically, the fit of the model was similar to Krusell et al.'s [Krusell, P., Ohanian, L., Ríos-Rull, J.V., Violante, G.L., 2000. Capital–skill complementarity and inequality: A macroeconomic analysis. Econometrica 68 (5), 1029–1053] using the NIPA data, but not the Greenwood et al. [Greenwood, J., Hercowitz, Z., Krusell, P., 1997. Long-run implications of investment-specific technological change. Amer. Econ. Rev. 87 (3), 342–362] data. Also, both series produce estimates of the elasticity of substitution between unskilled labor and equipment that are substantially larger than Krusell et al.'s [Krusell, P., Ohanian, L., Ríos-Rull, J.V., Violante, G.L., 2000. Capital–skill complementarity and inequality: A macroeconomic analysis. Econometrica 68 (5), 1029–1053] estimates.     

The role of factor substitution in the theory of economic growth and income distribution: Two examples

While much empirical evidence suggests that the Cobb–Douglas production function may be a reasonable benchmark for aggregate analysis, we argue that the practice, particularly prevalent in contemporary growth theory, of adopting the Cobb–Douglas technology, may lead to misleading implications. Using two examples, we show that key implications of the models are highly sensitive to small deviations of the elasticity of substitution from unity. The first employs the standard neoclassical model and emphasizes the sensitivity of the speed of convergence to small changes in the elasticity of substitution. This in turn has profound consequences for wealth and income distribution. The second deals with foreign aid and highlights how the relative merits of “tied” versus “untied” aid are also very sensitive to the elasticity of substitution.     

Comment on “Unwrapping some euro area growth puzzles: Factor substitution, productivity and unemployment”

This paper estimates the factor elasticity of substitution of the aggregate production function and then uses these estimates to resolve two puzzles relating to the Euro Area. The paper is novel in three ways: First it uses the CES production technology in the empirical strategy to understand real world economic phenomena; second it uses a frontier empirical methodology; and third it uses a new dataset.     

Estimating productivity and returns to scale in the US textile industry

In light of the textile industry's growing foreign competition, trade deficit and job loss, we estimate its productivity and efficiency for the period 1975–93 utilizing a variable elasticity of substitution production function. The results indicate that, despite job losses, the industry adjusted by increasing labor productivity and maintaining fairly stable profits. This performance does not warrant protectionist policies. However, with an elasticity of factor substitution less than one and decreasing, the impact of factor price increases could result in higher apparel prices and preference for cheaper imports. Furthermore, with an elasticity of capital output rapidly decreasing, significant technological improvements will be required to improve competitiveness since textile production is capital intensive. Recently revised rules on trade liberalization could increase competition in the industry. First version received: October 1999/Final version received: August 2000     

Intertemporal Substitution and Terms-of-Trade Shocks

The paper examines the relationship between transitory terms‐of‐trade shocks and private saving. Using a model allowing for nonseparability between the consumption of tradables and nontradables, the paper estimates the intertemporal elasticity of substitution while accounting for the intratemporal elasticity of substitution between the consumption of tradables and nontradables. Empirical analysis of data for five industrial countries indicates that in response to transitory terms‐of‐trade shocks, intertemporal substitution of consumption and intratemporal substitution of consumption between tradables and nontradables both have large effects on private saving.     

Sunspot Fluctuations in Two-sector Economies with Heterogeneous Agents

We study a two-sector model with heterogeneous agents and borrowing constraint on labor income. We show that the relative capital intensity difference across sectors is crucial for the conditions required to get indeterminacy and endogenous fluctuations. The main result shows that when the consumption good is sufficiently capital intensive, local indeterminacy arises while the elasticities of capital–labor substitution in both sectors are slightly greater than unity and the elasticity of the offer curve is low enough. Locally indeterminate equilibria are thus compatible with a low elasticity of intertemporal substitution in consumption and a low elasticity of the labor supply. As recently shown in empirical analysis, these conditions appear to be in accordance with macroeconomic evidences. We would like to thank R. Becker, J.P. Drugeon and an anonymous referee for useful comments and suggestions. The current version also benefited from a presentation at the conference “Public Economic Theory 04”, Beijing, August 2004.     

人民币贸易结算的影响因素 ——基于大国博弈视角的一般均衡分析

本文利用一个三部门（两个贸易部门、一个非贸易部门）的静态一般均衡模型，分别在名义工资黏性与实际工资黏性条件下分析货币供给冲击对贸易大国之间结算货币选择造成的影响。结论认为，出口商品结构、国内市场销售厂商占本国市场份额与同部门出口商占进口国市场份额的比值（市场份额比率）以及由汇率波动所引起的两国货币交易成本差额的变化对贸易大国之间结算货币选择策略具有决定性作用。为进一步推动人民币贸易结算的发展，中国与美国、欧盟和日本的进口交易可在产业内贸易模式下选取价格替代弹性较大、市场份额比率较高的产品作为推动人民币贸易结算的重点目标，同时应尽快提升人民币的可兑换性和流通能力，并尽量保持币值稳定以降低人民币对其他主要国际货币的交易成本。     

Product Market Imperfection and the Two‐sector Harris–Todaro Economy

This paper examines the ramifications of market imperfection for a dual economy in the context of the two‐sector Harris–Todaro model with the agricultural (manufacturing) sector under perfect competition (monopoly). Based on a utility function of constant elasticity of substitution variety, it demonstrates (i) existence of a unique equilibrium at which the consumer price ratio and the producer price ratio are synchronized; (ii) several fundamental properties of the model (crucial to extended research on this subject area); (iii) contrary to an earlier result obtained under an oligopolistic manufacturing sector, trade liberalization for a small economy may be immiserizing.     

A Fiscal Stimulus and Jobless Recovery

We analyze the effects of a government‐spending expansion in a dynamic stochastic general equilibrium model with Mortensen–Pissarides labor‐market frictions, deep habits in private and public consumption, investment adjustment costs, a constant elasticity of substitution (CES) production function, and adjustments in employment at both intensive and extensive margins. The combination of deep habits and CES technology is crucial. The presence of deep habits magnifies the responses of macroeconomic variables to a fiscal stimulus, while an elasticity of substitution between capital and labor in the range of available estimates allows the model to produce a scenario compatible with the observed jobless recovery.     

The determinants of bilateral trade

Abstract.  In this paper we present a monopolistic competition model that incorporates asymmetric trade barriers and international differences in production costs. The model implies a highly non‐linear bilateral trade equation. Estimation of this equation yields parameters for the elasticity of substitution and trade costs that are more reasonable than those found in previous studies. A simulation indicates that trade liberalization will shift trade from rich countries to poor countries and from within continental trading partners with preferential trade agreements to intercontinental trading partners. JEL Classification: F1     

Goods market responses to trade shocks and trade and wages decompositions

Abstract.  Trade and wages literature asks whether trade or technology has been the major factor behind increases in wage inequality in OECD countries since the 1980s. In this literature, little attention has been paid to how goods market responses to trade shocks affect conclusions. Using an Armington heterogeneous goods trade model we capture demand side effects, and show how trade shocks affecting the price of unskilled‐intensive importable goods can be absorbed on the demand side of goods markets, with little or no impact on relative wage rates. No wage impact occurs if the elasticity of substitution in preferences between imports and import substitutes is one. As this elasticity increases, trade plays an ever larger role in explaining wage inequality changes, and as the elasticity goes below one the sign of the effect changes. We present some results of general equilibrium decompositions of total wage change into trade and technology components using UK data. We suggest that since many import demand elasticity estimates are in the neighbourhood of one, there is a prima facie case that goods market considerations further lower the significance of trade as an explanation of recent trends in OECD wage inequality beyond that claimed in the literature.     

The impacts of Renminbi appreciation on trade flows and reserve accumulation in a monetary trade model

Given the rapidly growing reserves in Asia (China, Japan, Korea, and Taiwan) and the pressures from trading partners to revalue, there is a need to examine commercial policy in more than a pure barter model. Here we evaluate the joint impacts of exchange rate appreciation on trade flows and country surpluses using a general equilibrium trade model with a simple monetary structure in which the trade surplus is endogenously determined in the exchange rate setting country and the exchange rate is exogenous. We illustrate its application to the Chinese case using calibration to 2005 data. Our results, while elasticity dependent, suggest that the impacts of Renminbi (RMB) revaluation on the surplus are proportionally larger than on trade flows, and that changes in trade flows can be substantial. Different treatments of China's processing trade have small impact on changes in China's trade flow under RMB appreciation, but significant impacts on the change in the surplus. Results are elasticity dependent; larger substitution elasticities in preferences yield larger effects on trade flows and the surplus.     

Currency Unions,Export Margins,and Product Differentiation: An Empirical Assessment for European Monetary Union

This paper reconsiders the trade effects of the euro, providing a decomposition into its effects on the extensive margin and intensive margin. Furthermore, it relates the more disaggregated estimates for 93 two‐digit HS product groups to the elasticity of substitution, thereby testing a key hypothesis of heterogenous firm trade theory. The estimates for the period 1996–2011 suggest a trade effect of the euro of some 28%, which has mainly materialized through the intensive margin. A negative net effect of the euro on the extensive margin is found for several product groups, supporting anecdotal evidence that firms have consolidated their product varieties in response to the elimination of exchange rate variability. Finally, the disaggregated estimates are in line with heterogenous firm trade theory models, suggesting that a large elasticity of substitution dampens the effect of a trade cost reduction on the extensive margin and amplifies its effect on the intensive margin.